FBIAS™ for the week ending 3/21/2014

In the “decades” timeframe, we are in a Secular Bear Market which began in 2000 when the P/E ratio (using Shiller’s Cyclically-Adjusted P/E, or “CAPE”) peaked at about 44. The job of Secular Bear markets is to burn off outrageously high P/E ratios over one or two decades, until finally the P/E ratio arrives back at a single-digit level, from which another Secular Bull Market can emerge. See graph below for the 100-year view of this repeating process.

If history is a guide, we may not yet be done with this Secular Bear Market. The Shiller P/E finished the week at 25.7, up slightly from the prior week’s 25.5, and approximately at the level reached at the pre-crash high in October, 2007. Even though P/E’s are substantially lower than their crazy peak in 2000, they are nonetheless at the high end of the normal historical range and leave little if any room for expansion. This means that the stock market is unlikely to make gains greater than corporate profit growth percentage, if that. (note: all P/E references are to the Shiller P/E values, sometimes called PE10 or CAPE, which are calculated so as to remove shorter-term fluctuations; see robertshiller.com for details).

In fact, since 1881, the average annual returns for all ten year periods that began with a CAPE at this level have been just 3%/yr (see graph below).

This further means that above-average returns will be much more likely to come from the active management of portfolios than from passive buy-and-hold. Although a mania could come along and cause P/E’s to shoot upward from current levels (such as happened in the late 1920’s and the late 1990’s), in the absence of such a mania, buy-and-hold investors will likely have a long wait until the arrival of returns typical of a Secular Bull Market.

In the big picture:

The “big picture” is the months-to-years timeframe – the timeframe in which Cyclical Bulls and Bears operate. The US Bull-Bear Indicator (see graph below) is at 68.8, down slightly from last week’s 69.1, and still solidly in cyclical Bull territory. For the last three years, the US Bull-Bear Indicator has pushed further into Bull territory than other global asset classes, reflecting the higher strength of the US relative to the rest of the world. The current Cyclical Bull has taken the US to new all-time highs, exceeding the highs of 2007, but most of the world’s major indices have barely matched 2011’s highs, let alone approached 2007’s levels.

In the intermediate picture:

The intermediate (weeks to months) indicator (see graph below) remains in positive status, ending the week at 26, down from the prior week’s 27. Separately, the quarter-by-quarter indicator – based on domestic and international stock trend status at the start of each quarter – gave a positive indication on the first day of January for the prospects for the first quarter of 2014.

Timeframe summary:

In the Secular (years to decades) timeframe (Figs. 1 & 2 above), the Secular Bear still is in force as the long-term valuation of the market is too high to sustain a new rip-roaring Secular Bull. In the Cyclical (months to years) timeframe (Fig. 3 above), all major equity markets are in Cyclical Bull territory, with the US being far stronger than any other major market. The Bond market returned to Cyclical Bull territory as of February 28th. In the Intermediate (weeks to months) timeframe (Fig. 4 above), US equity markets remain in positive status. The quarter-by-quarter indicator gave a positive signal for the 1st quarter: both US and International equities were in uptrends at the start of Q1, which signals a higher likelihood of an up quarter than a down quarter.

In the markets:

The year-to-date laggards played catch-up and were the leaders for the week. In the US, the Dow Industrials gained +1.5% to lead all US indices, while the beaten-down Emerging International group gained +1.5% on average, far outstripping Developed International, which was just barely positive for the week. Brazil, also among negative year-to-date performers, led all major country markets for the week by gaining +6.5%. The high-flying Nasdaq was hit hard at the end of the week when a number of previously-hot biotechs were sold off aggressively. Conversely, the previous poor-performing Financials sector got red-hot following the Fed’s release of so-called “Stress Test” results: 29 of 30 major banks met or exceeded the capital required to withstand a near depression. Canada’s TSX Composite Index gained +0.8% for the week.

In the US, economic news was mostly positive. Some might say “too positive”, as it may have given rise to Janet Yellen’s off-the-cuff guesstimate that rate tightening could occur as early as “…on the order of around six months or that type of thing.”, which temporarily spooked markets. U.S. factory output rose +0.8% in February, the biggest gain since August, energy prices fell for the first time in 3 months, building permits jumped +7.7%, the Consumer Price Index (“CPI”) rose just +0.1% in February, in line with expectations, and is up just +1.1% year-over-year. The Philly Fed survey came in at a robust 9 vs. expectations of just 3.2, although the Empire State manufacturing survey missed its expectations.

Canadian central bankers heaved a sigh of relief as consumer prices were reported to have risen +1.1%, higher than expectations and within the central bank’s target range of +1% to +3% – and easing deflationary fears at least temporarily. Canadian aircraft manufacturer Bombardier looks to be a victim of collateral damage from the sanctions imposed by the West on Russia over its annexation of Crimea. The company had been relying on Russian deals worth between $3 and $4 billion over the next few years, but the orders are now in jeopardy as more and more financial sanctions are put in place. Bombardier’s stock is down -9.5% year-to-date, compared to a higher Canadian market overall.

Although most of Europe has been fixated on the potential of higher energy costs of imports from Russia, at least Europeans have been out buying cars: European car sales rose +7.6% in February, and was the sixth straight month of increasing sales.

China’s growth continues to slow. Chinese industrial production dropped from +9.7 percent year-over-year to +8.6 percent in February, the lowest since 2009. The weak number calls into question whether China will meet the government’s growth target of 7.5%. Retail sales growth also fell sharply in February, to +11.8% from a year ago. The growth rate is the lowest in nine years.

Lastly, as a fitting tribute to the mismanagement of Venezuela’s late socialist President Hugo Chavez, annualized inflation in Venezuela was reported by its Central Bank as 57.3% in February; central bank president Nelson Merentes admitted the obvious, that Venezuela is in the midst of an economic crisis.

The ranking relationship (shown in Fig. 5) between the defensive SHUT sectors (“S”=Staples [a.k.a. consumer non-cyclical], “H”=Healthcare, “U”=Utilities and “T”=Telecom) and the offensive DIME sectors (“D”=Discretionary [a.k.a. Consumer Cyclical], “I”=Industrial, “M”=Materials, “E”=Energy), is one way to gauge institutional investor sentiment in the market.

The average ranking of Defensive SHUT sectors rose sharply to 11.0 from the prior week’s 14.8, while the average ranking of Offensive DIME sectors fell to 14.8 from the prior week’s 12.8. The Defensive SHUT sectors have grabbed a new lead over the Offensive DIME sectors.

Note: these are “ranks”, not “scores”, so smaller numbers are higher and larger numbers are lower.

Summary:

The US led the recovery from 2011’s travails, and continues to be the strongest among all global markets. However, the over-arching Secular Bear Market may remain in place even as new highs are reached in the US.

Because we may still be in a Secular Bear, we have no expectations of runs of multiple double-digit consecutive years, and we expect poor market conditions to be a frequent occurrence. Nonetheless, we remain completely open to any eventuality that the market brings, and our strategies, tactics and tools will help us to successfully navigate whatever happens.

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